Assurant 2012 Annual Report Download - page 65

ASSURANT, INC.2012 Form10-K 57
PARTII
ITEM 7A Quantitative and Qualitative Disclosures About Market Risk
Liabilities for future policy bene ts and expenses of $8,513,505 and
claims and bene ts payable of $3,960,590 have been included in the
commitments and contingencies table. Signi cant uncertainties relating
to these liabilities include mortality, morbidity, expenses, persistency,
investment returns, in ation, contract terms and the timing of payments.
Letters of Credit
In the normal course of business, letters of credit are issued primarily to
support reinsurance arrangements.  ese letters of credit are supported
by commitments with  nancial institutions. We had approximately
$19,760 and $24,946 of letters of credit outstanding as of December31,
2012 and December31, 2011, respectively.
Off -Balance Sheet Arrangements
 e Company does not have any o -balance sheet arrangements that
are reasonably likely to have a material e ect on the  nancial condition,
results of operations, liquidity, or capital resources of the Company.
ITEM 7A Quantitative and Qualitative Disclosures About
Market Risk
As a provider of insurance products, e ective risk management
is fundamental to our ability to protect both our customers’ and
stockholders’ interests. We are exposed to potential loss from various
market risks, in particular interest rate risk and credit risk. Additionally,
we are exposed to in ation risk and to a lesser extent foreign currency risk.
Interest rate risk is the possibility that the fair value of liabilities will
change more or less than the market value of investments in response
to changes in interest rates, including changes in investment yields and
changes in spreads due to credit risks and other factors.
Credit risk is the possibility that counterparties may not be able to meet
payment obligations when they become due. We assume counterparty
credit risk in many forms. A counterparty is any person or entity from
which cash or other forms of consideration are expected to extinguish
a liability or obligation to us. Primarily, our credit risk exposure is
concentrated in our  xed maturity investment portfolio and, to a lesser
extent, in our reinsurance recoverables.
In ation risk is the possibility that a change in domestic price levels
produces an adverse e ect on earnings.  is typically happens when
either invested assets or liabilities, but not both is indexed to in ation.
Foreign exchange risk is the possibility that changes in exchange rates
produce an adverse e ect on earnings and equity when measured in
domestic currency.  is risk is largest when assets backing liabilities
payable in one currency are invested in  nancial instruments of another
currency. Our general principle is to invest in assets that match the
currency in which we expect the liabilities to be paid.
Interest Rate Risk
Interest rate risk arises as we invest substantial funds in interest-sensitive
 xed income assets, such as  xed maturity securities, mortgage-backed
and asset-backed securities and commercial mortgage loans, primarily
in the United States and Canada.  ere are two forms of interest rate
risk—price risk and reinvestment risk. Price risk occurs when  uctuations
in interest rates have a direct impact on the market valuation of these
investments. As interest rates rise, the market value of these investments
falls, and conversely, as interest rates fall, the market value of these
investments rise. Reinvestment risk is primarily associated with the
need to reinvest cash  ows (primarily coupons and maturities) in an
unfavorable lower interest rate environment. In addition, for securities
with embedded options such as callable bonds, mortgage-backed
securities, and certain asset-backed securities, reinvestment risk occurs
when  uctuations in interest rates have a direct impact on expected
cash  ows. As interest rates fall, an increase in prepayments on these
assets results in earlier than expected receipt of cash  ows forcing us to
reinvest the proceeds in an unfavorable lower interest rate environment.
Conversely, as interest rates rise, a decrease in prepayments on these
assets results in later than expected receipt of cash  ows forcing us
to forgo reinvesting in a favorable higher interest rate environment.
We manage interest rate risk by selecting investments with characteristics
such as duration, yield, currency and liquidity tailored to the anticipated
cash out ow characteristics of our insurance and reinsurance liabilities.
Our group long-term disability and group term life waiver of premium
reserves are also sensitive to interest rates.  ese reserves are discounted
to the valuation date at the valuation interest rate.  e valuation interest
rate is determined by taking into consideration actual and expected
earned rates on our asset portfolio.
 e interest rate sensitivity relating to price risk of our  xed maturity
securities is assessed using hypothetical scenarios that assume several
positive and negative parallel shifts of the yield curves. We have assumed
that the United States and Canadian yield curve shifts are of equal
direction and magnitude.  e individual securities are repriced under
each scenario using a valuation model. For investments such as callable
bonds and mortgage-backed and asset-backed securities, a prepayment
model is used in conjunction with a valuation model. Our actual
experience may di er from the results noted below particularly due
to assumptions utilized or if events occur that were not included in
the methodology.